Stumptown in a K-Cup? Keurig deal brings margin opportunity

NEW YORK (Reuters) - Taking coffee maker Keurig Green Mountain Inc GMCR.O private will give JAB Holding Co an opportunity to press for higher margins and even increase prices for the single-serve K-Cups used in about 21 million U.S. homes, analysts and industry bankers said.

A single-serve Keurig Green Mountain brewing machine is seen in New York February 6, 2015. REUTERS/Shannon Stapleton

JAB said on Monday it would buy Keurig for $13.9 billion, its biggest acquisition in a quest to build a global coffee powerhouse to better compete with Switzerland’s Nestle SA NESN.VX. The announcement prompted comparisons on Wall Street between JAB’s strategy and that of brewer Anheuser-Busch InBev ABR.BI, though some industry watchers were sobered by the high price paid for Keurig, which is struggling with competition in single-serve pods and a failed product launch.

While some of the more immediate benefits of a deal would come from JAB’s heightened leverage in sourcing coffee beans, the bigger opportunity lies in the greater profit of distributing JAB’s expanding portfolio of brands, including higher-end “craft” names like Peet’s Coffee & Tea, Caribou and Stumptown Coffee Roasters, analysts and bankers said.

Some of those brands already produce K-Cups for Keurig machines under licensing agreements, but as company-owned brands those arrangements would provide higher margins.

Overall, Keurig’s dominance of the U.S. single-serve market is a clear competitive advantage, said Jonathan Feeney, an analyst at Athlos Research. “They (JAB) can handle the brand strategy, the partner strategy, any way they want.”

JAB could also raise prices on pods, especially since Keurig will be privately held and face far fewer requirements to disclose how it runs its business, Feeney said. As a result, partners who have licensing agreements with Keurig to make the pods, such as Starbucks Corp (SBUX.O) and Dunkin’ Brands Group (DNKN.O), would not know how much Keurig is making from those deals and could find it harder to demand a greater cut.

FILTER OR ESPRESSO?

Whether Keurig will help JAB make greater inroads in Europe at the expense of Nestle remains a question, industry experts said, particularly in the single-serve market where Nestle serves espresso-style drinks rather than the American-style K-Cup which more closely resembles filter coffee. “I suspect they would need a modified machine,” said Robert Waldschmidt, a research analyst at investment bank Liberum.

Others see room for more filter-style coffee in Europe.

“Every meeting you go to, there is still a pot of coffee on the table that’s not espresso,” said one industry banker who was not involved in the deal. “There’s a lot of people drinking Americanos in Europe. There should be a market for this machine.”

While significant risk exists that brands like Starbucks and Dunkin Donuts could cut ties with Keurig once it is owned by JAB and opt for other partners to manufacture branded pods, analysts and bankers said it was unlikely.

“These are significant streams of cash flow to these companies,” Feeney said. “It’s not trivial for them to say ‘OK we’ll just do this ourselves.’”

Starbucks did not respond to a request for comment. Dunkin’ said in a statement that “we anticipate no change in how we work with Keurig.” JAB’s plan does not come cheap, as it will pay a 78 percent premium to Keurig’s closing share price as of Friday.

“I do suspect they wanted to act quickly and in this instance certain key minority partners like (Coca-Cola Co (KO.N) ) are made whole,” Waldschmidt said. “This likely ensures that they get the deal done quickly with no competing bids.”

Additional reporting by Martinne Geller in London and Lauren Hirsch in New York; Editing by Matthew Lewis